Financial crisis fallout: from your stocks to America's global role

ByDavid R. FrancisOctober 20, 2008

"We're Headin' for Armageddon," said one press release headline earlier this month as the United States stock market plunged to depths not seen since 2002.

With the credit freeze in the US, similar financial turmoil around much of the world, and the coordinated bank rescue action, talk of a "new economic era" has won some credibility. So what are the consequences of the financial crisis in the months and years ahead? Let's examine three areas:

"A teddy bear has quickly turned into a grizzly bear," notes Robert Froehlich, chief investment strategist for DWS Investments, the American wing of Deutsche Bank's global asset management division. On Friday, Oct. 10, the Dow Jones Industrial Average experienced its most price-volatile single day since this index of major corporate stocks was created in 1896.

Fear turned to panic, Dr. Froehlich observes. There was a massive 3 percent liquidation of the entire money-market industry in one day. It was a run on the banks like in the Great Depression but with no lines around banks because orders were placed online or by telephone. "Just because you didn't see it, doesn't mean it didn't happen."

Yet Froehlich regards stocks as priced for a "50 percent off fire sale."

At the market bottom, 3,518 of 9,194 stocks tracked by S&P were trading at less than eight times their prior year's earnings. The historic average is 16 times. Nearly 10 percent (876) of the total were trading below the value of their per share holdings of cash, notes Froehlich. He sees "an unbelievable buying opportunity."

The problem is that no one knows when enough investors will agree to move their cash back into stocks to end the bear market.

The US economy

Most economists figure the economy is in a recession, but differ on the depth and length of the slump. Much depends on whether the credit squeeze eases as a result of the numerous government measures announced or already in place.

The general tenor of the political scene is moving left, says Bradford DeLong, a former Clinton Treasury official now teaching economics at the University of California, Berkeley. History shows free market principles are "forgotten fast" when a financial crisis comes along, he says. So the major banks are being partly nationalized.

Even the late Milton Friedman, the famed advocate of stable growth in the nation's money supply, would have advocated drastic measures to keep the money supply stable rather than shrinking in a financial crisis, says Professor DeLong.

Noting that it is financial institutions being rescued, he comments critically: "Rugged individualism applies only to the poor and the middle class."

A Chicago Council on Global Affairs public opinion survey released last week found 60 percent of Americans believe the next generation of Americans will be economically worse off than today's working adults.

There's some speculation that as consumers tighten their belts by spending less and saving more, the American standard of living will shrink a little.

At the same time, the rescue package will not do much to restrain corporate executive earnings in the US.

"I'm very discouraged," says Sarah Anderson of the progressive Institute for Policy Studies, after analyzing the new Treasury rules on executive compensation. She has more hope for legislation to limit CEO pay, say to 25 times the wages of the lowest paid employee in a firm – should Democrats control Congress next year.

Professor Temin is encouraged by the strength of the US dollar on foreign exchange markets in recent days. Normally, he says, a financial crisis in a country prompts investors to flee that nation's currency. But international investors apparently regard US Treasury bonds as the safest investment in the world and see Europe as in "more disarray" than even the US.

Even so, the rise of developing country economies, such as those of China and India, is expected to continue and gradually diminish the US proportion of the world economy.